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Nadeem Walayat Financial Markets Analysiis and Trend Forecasts

Gold, Silver and Unhedged Producers

Commodities / Gold and Silver 2011 Jan 20, 2011 - 06:27 AM GMT

By: Bob_Kirtley

Commodities

Best Financial Markets Analysis ArticleThe run up in gold prices attracted investors to the gold and silver mining sector and for those investors looking for significant exposure, producers who do not forward sell their production provide the vehicle to take advantage of the improvement in gold prices. However during the recent pull back in both silver and gold prices these stocks naturally experienced some profit taking, particularly by speculators who have recently taken an interest in this small sector of the market.




Taking a quick look at the above chart, which compares the progress of the HUI with that of gold prices we can see the HUI has been tracking gold closely until this recent down turn when the HUI has moved considerably lower. This is a disappointment to us as the stocks appear to head lower faster than the metals but they also appear to move higher slower than the metals.

The HUI is The AMEX Gold BUGS Basket of Unhedged Gold Stocks Index and represents a portfolio of 14 major gold mining companies. The Index is designed to give investors significant exposure to near term movements in gold prices - by including companies that do not hedge their gold production beyond 1 1/2 years.)

The attraction of investing in stocks is that the stocks should offer leverage by as much as 3:1, 4:1 or 5:1 to the metals, otherwise investors cannot see the point in taking the many and varied risks that are inherent in the mining industry, if the returns are mediocre. The phase we are in right shows that the stocks are struggling to manage a 1:1 ratio with the metals.

The chart below compares Gold to the HUI and as we can see since 2006 the stocks have struggled to keep pace with gold and the divergence appears to getting wider. So, is this a buying opportunity or have indeed things changed suggesting that the stocks may not be the best way to play this Golden Bull, after all this is not 1980 and there are other vehicles available which are consuming a fair amount of investors cash. There are a variety of Exchange Traded Funds that specialize in gold itself and everyday now we see the launch of a new vehicle offering a slightly different slant on the way to play this market. These vehicles offer exposure to gold, ease of access and liquidity along with a price that moves almost in lock step with gold.

There is no doubt in our minds that the gold producers are in for a good time but this is not a monopolistic environment so they now need to become more creative in order to attract and maintain their customers. A half decent dividend would be a starting point, offering existing share holders the opportunity of participation in the next stock offering, offer the product they mine for purchase by their own the investors, etc. Some companies are in the process of doing some of these things but not all. The businesses that cannot keep up with gold prices need to find an olive branch and come up with something revolutionary that secures their market share, otherwise funds will move to a safer and more profitable place. Miners, You have been warned so get your skates on.

As our readers know we have been and are still firmly ensconced in the inflationary camp and apart from the massive price increases that have hit the commodities market in general there are signs that inflation is pushing through, such as the UK have just announced. Oil prices took the blame as the

annual CPI growth moved up in December to an eight-month high of 3.7 percent, well above the 2.0 percent target, giving the Bank of England a new headache. Also note that these figures do not include the latest rise in VAT (Value Added Tax) in the UK which will no doubt boost this figure even higher next time around.

For what its worth our strategy remains unchanged with the purchase and holding of physical gold first, followed by a small number of stocks and then a few options trades to in an attempt to get the leverage that the stocks are not delivering at the moment. In fact we are so confident that gold prices will rise that we have offered to refund the fee paid to our premium options trading service should gold prices not hit $1500/oz this year.

Whilst being dragged mercilessly around the shops the other day I spotted a jewelers shop with the usual signs outside saying that they buy and sell gold and silver etc. It looked like a good place for some respite and an opportunity to find out just what is happening at the High Street end of things.

We kicked off with a polite inquiry about us wishing to purchase both gold and silver coins and bars for investment purposes. The shop owner, resplendent in apron, goggles, head bands and high powered magnifying glasses gave us a perplexed look.

Do you know, he said, that I took delivery of both, enough to last this shop five weeks and it all went in a day and a half. However, I have placed another order and when you are certain of exactly what you want you can piggy back on the back of my order but we can not give you a delivery date as things are a bit manic at the moment. He went on to say that investment demand was now outstripping his demand for jewelry, which although he was happy to get the business he was surprised at just how fast it was moving.

He also told us that people who had bought three months ago returned in the first week of January 2011 and paid cash for immediate possession. He likened his business to the bakery next door with the proviso that he was handling much bigger numbers. He wasn’t prepared to tell us just how big as we had just walked through the door and he didn’t know us. We asked how much gold and silver his customers brought back to make a profit when the price had increased, he laughed and gave us that look! None of his customers who had purchased precious metals for investment purposes had tried to sell it back to him, however, he was getting a steady flow of broken jewelry that people would cash in and his pride and joy as a craftsman was to repair the objects and display them in his window.

This is not a scientific experiment, but the owner did dwell on the supply side difficulties that he was experiencing so this would appear to be in line with most of what we have picked up from our peers, the media, other sites, etc.

It suggests that the physical supply and availability of gold and silver as we have alluded to in the past and has been reported on many other sites such as King World News, is still very tight indeed

The difficulty we wrestle with is can silver do it again, put in a repeat performance equal to that of last year, especially in the latter half of the year when it went from $18.00/oz in August to $30/oz in December 2010. Normally we would say that this is highly improbable but every time we have a knock down and drag out session we come back to very similar conclusions that silver will indeed have another very good year. Gold prices may steal the limelight and power ahead making record breaking headlines, however, silver prices will be there or thereabouts. We lean towards the theory that the shear numbers of people in China, India, Asia, etc, that are steadily increasing their wealth will be able to afford some silver as their financial position improves and should they gain some traction then gold prices will appear less daunting and so they start to accumulate some gold too. Also, the investors/speculators who have made some good profits in silver may decide that the time has come to change horses and allocate some of their capital to gold in the hope that a better percentage gain can be had. Its going to be a very interesting year and a pretty bumpy one at that.

Just our thoughts of course.

To stay updated on our market commentary, which gold stocks we are buying and why, please subscribe to The Gold Prices Newsletter, completely FREE of charge. Simply click here and enter your email address. (Winners of the GoldDrivers Stock Picking Competition 2007)

For those readers who are also interested in the silver bull market that is currently unfolding, you may want to subscribe to our Free Silver Prices Newsletter.

DISCLAIMER : Gold Prices makes no guarantee or warranty on the accuracy or completeness of the data provided on this site. Nothing contained herein is intended or shall be deemed to be investment advice, implied or otherwise. This website represents our views and nothing more than that. Always consult your registered advisor to assist you with your investments. We accept no liability for any loss arising from the use of the data contained on this website. We may or may not hold a position in these securities at any given time and reserve the right to buy and sell as we think fit.
Bob Kirtley Archive

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